Rates of Return on Direct Investment

August      

By J. Steven Landefeld, Ann M. Lawson, and Douglas B. Weinberg

Paul W. Farello,   updates the alternative meas- . This price adjustment is larger for  Ilona C. T ures prepared by the Bureau of Economic because most  occurred in the ’s and Greenberg, and Glenn Farello of Analysis () of the rates of return on foreign ’s and thus tends to be “older” than , the Balance of direct investment in the United States () most of which occurred in the ’s. Payments Division and on U.S. direct investment abroad (). It For , the rates of return at market value and Steve B. Bezirganian and compares these rates of return with those on all- and at current cost are similar, on average, to the Arnold Gilbert of U.S.-business investment and discusses possible rates of return for all U.S. businesses. However, the International explanations for the relatively low rates of return for , the rates of return at market value and Investment on . Division assisted in at current cost are considerably below the rates providing data and Last year,  introduced two alternative meas- of return for all U.S. businesses. (The historical- performing ures of the rate of return on direct investment cost rates of return for  are also quite low.) methodological that were based on  estimates of the direct research for this The remainder of this article examines the ques- article. investment positions valued at current-period tion of why the rates of return on  are so prices: The return on direct investment positions low relative to the rates of return on domestic at market value, which is a measure of financial investments. returns to direct investment, and the return on direct investment positions valued at current cost, . For other recent studies on  and the low rates of return on , which is a measure of economic returns on di- see Harry Grubert, Timothy Goodspeed, and Debrah Swenson, “Explaining  the Low Taxable Income of Foreign-Controlled Companies in the United rect investment from current operations. These States,” unpublished, contact author, Harry Grubert, U.S. Treasury) Novem- ber ; Edward M. Graham and Paul R. Krugman, Foreign Direct Investment alternative measures overcome a major limitation in the United States, d edition (Washington, : Institute for International of estimates of rates of return based on historical Economics, ); and “Review of Internal Revenue Service Statistics on Foreign Controlled Domestic Corporations  through ,” prepared by costs—the noncomparability of investments that  Peat Marwick for the Organization for International Investment, July differ considerably in age and therefore in price— . by presenting estimates on a consistent valuation basis. Table 1.ÐAlternative Measures of the Rate of Return Table  shows rates of return for  and for U.S. Direct Investment Abroad, Foreign Direct  based on market value and on current cost Investment in the United States, and All U.S. Businesses compared with a market rate of return for all [Percent] U.S. businesses; it also shows rates of return for Returns based Returns based Returns based on  on historical on current cost market value  and  based on historical costs. For cost both  and , the rates of return at All U.S. current-period prices are lower, on average, than USDIA FDIUS USDIA FDIUS busi- USDIA FDIUS ness- the rates of return at historical costs. However, es 1 the differences are much larger for  than 1982 ...... 11.4 2.7 6.0 1.2 n.a. n.a. 11.0 for  because the adjustment needed to re- 1983 ...... 12.9 3.9 7.0 2.3 11.4 4.0 9.9 1984 ...... 14.4 6.3 8.3 4.4 11.6 5.7 11.1 state direct investment positions from historical 1985 ...... 12.6 4.3 7.9 3.3 9.1 3.2 8.7 1986 ...... 12.2 3.7 7.6 2.8 7.2 2.2 7.2 costs to current-period prices is much larger for 1987 ...... 13.4 3.6 8.3 2.6 7.7 2.5 8.1 1988 ...... 15.5 4.4 10.0 3.4 8.4 3.9 9.0 1989 ...... 15.2 2.2 10.2 1.6 7.9 2.2 7.6 . For a discussion of the various measures, see “Alternative Measures of 1990 ...... 13.8 .4 9.4 .2 7.6 −.3 7.7 the Rate of Return on Direct Investment,” S  C B  1991 ...... 11.2 −.7 7.7 −.8 6.9 −.2 6.0 (August ): –. For a discussion of the estimates of direct investment Average, 1983±91 ..... 13.5 3.1 8.5 2.2 8.7 2.6 8.4 at market value and current cost, see “The International Investment Position of the United States in ,” S  (June ): –. For a discussion n.a. Not available. of the concepts and estimating procedures underlying the current-period 1. This measure is a weighted average of the after-tax earnings per dollar of stock for Standard and Poor's Composite 500 companies and the average yield on corporate bond estimates of direct investment, see “Valuation of the U.S. Net International holdings rated AAA by Moody's Investors Service. The returns on debt and equity are Investment Position,” S  (May ): –. weighted by the ratio of debt to equities at market value for nonfinancial corporate businesses published by the Board of Governors of the Federal Reserve System,Balance Sheets for the . The data are limited to the period from  or  to  because the U.S. Economy, 1960±91, (Washington, DC: March 1992). complete information on equity flows and equity positions that is required USDIA U.S. direct investment abroad for the market-value measure is unavailable for earlier years. FDIUS Foreign direct investment in the United States  August      •

Returns on  erable portion of this new  consisted of acquisitions of financially distressed U.S. compa- In examining rates of return on ,itisim- nies that foreign companies presumably hoped to portant to note that a multinational company restructure and restore to financial health. tries to maximize its total profits around the Long-term factors associated with the goal of world in deciding where to invest, where to pro- maximizing profits on a global basis rather than duce, and where to realize its income. As a result, on an individual-country basis also may have a multinational company structures its opera- held down the rates of return on . These tions, costs, and product pricing across countries factors included the following: Economies of to maximize its global profits rather than to max- scale and the advantages of vertical integration, imize profits on an individual investment or even differences between countries in the treatment on all of its investments in a single country. It of taxes, and avoidance of tariffs and nontariff may accept a below-average profit to gain ac- barriers. cess to the large U.S. market or to scarce raw materials. Alternatively, it may accept low re- The analysis that follows covers the rates of returns on some parts of its operations to take turn on  for  of the  countries that were the largest direct investors in the United States advantage of economies of scale and technolog-  ical efficiencies in other parts of its operations. during the last decade. In , these  coun- In addition to these types of operational—or tries accounted for over  percent of cumulative industrial organization—factors, multinationals , and the top  accounted for over  per- also take into account a number of other factors, cent (table ). It should be noted that underlying such as differences across countries in the cost economic conditions and motivations for direct and availability of capital, in expected returns on investment vary markedly among these countries, investment, in the tax treatment of income, and and it is difficult to generalize about the fac- in tariffs and nontariff barriers. tors leading to low rates of return on their direct The low rates of return on  appear to re- investments. flect certain long-term factors associated with the operations of multinational companies and the

effects of a number of transitional factors that . Although the Netherlands Antilles’  position ranks eighth among led to a surge in  in the ’s. In the all countries, it is excluded from the analysis because of the unique nature of its inward investment, which resulted from its activity as an offshore financial ’s, current-account surpluses in Japan and center (offshore financial centers were created to avoid certain interest-rate several other countries generated excess funds controls, bank lending restrictions and reserve requirements, and other regu- latory constraints). Additionally, it had a favorable tax treaty with the United available for investment. Funds were attracted States that offered an exemption from the withholding tax on certain interest to the United States by average yields on U.S. payments from U.S. affiliates to their Antillean parents. Consequently, foreign corporations made large investments in the United States through their investments that were higher than those on Antillean affiliates rather than investing directly in the United States. home-country investments; this spread allowed However, over the past decade, the Netherlands Antilles’ share of total  has declined substantially. Its current-dollar position has remained foreign investors to accept yields that were below fairly constant since , while its real share of total  has declined the average yield on U.S. investments. Further, from  percent in  to  percent in . This downtrend can be partly explained by the elimination of U.S. withholding taxes on interest payments depreciation of the dollar against most foreign to foreigners in , which largely nullified the Netherlands Antilles’ unique currencies in the latter half of the ’s increased tax advantage. potential long-term yields for those investors who believed that the U.S. dollar was undervalued. Table 2.ÐTop 10 Countries with Largest Foreign Direct The combination of these factors meant that in- Investments in the United States, 1991

vestments that had looked attractive from an Millions of Percent of operations perspective now also looked attractive dollars total

from an investment perspective. The resulting All countries ...... 407,577 100 surge in  in the ’s meant that much Top 10 countries ...... 371,927 91 of the investment on which the rates of return United Kingdom ...... 106,064 26 are calculated was relatively new, and new invest- Japan ...... 86,658 21 Netherlands ...... 63,848 16 ments typically have lower rates of return than Canada ...... 30,002 7 Germany ...... 28,171 7 more mature investments. Moreover, a consid- France ...... 22,740 6 Switzerland ...... 17,594 4 . There has been much discussion about the relative importance of cost- Australia ...... 6,626 2 of-capital and macroeconomic explanations versus industrial-organization Sweden ...... 5,597 1 Belgium/Luxembourg ...... 4,627 1 explanations for direct investment. Most analysts concede that both have a role in direct investment but that industrial-organization explanations tend Netherlands Antilles 1 ...... 7,948 2 to have a larger role than the other explanations. See, for example, Graham and Krugman in Foreign Direct Investment, –. 1. See footnote 5 in the text.     August   •

Transitional factors For several of these major investor countries, the difference between returns on direct equity investments was substantial. For example, Differences in average yields.—During much of Japanese investors received an average yield of the last decade, average yields on investments in . percent on their equity  between  the top  investor countries were below those and , compared with a yield of . percent in the United States (table ). Between  and on Japanese equities. Thus, returns on Japanese , the average real rate of return on total in- investments in the United States raised Japanese vested capital—debt and equity combined—was investors’ aggregate yields, even though they were . percent in these countries, compared with . lower than the all-U.S.-business average. percent in the United States. The average yield on debt in these countries was . percent, compared Depreciation of the dollar.—A second and more with . percent; the average yield on equities was important factor increasing  in the ’s . percent, compared with . percent. was the decline in the value of the U.S. dollar. In the latter half of the ’s, the real value of Table 3.ÐRates of Return in the United States and the dollar declined  percent, and foreign firms in the Top 10 Investor Countries more than doubled their direct investment posi- [Percent] tion. This surge in  was similar to one that

Average in the United Average in the top 10 in- occurred between  and , when the dol- States vestor countries lar depreciated about  percent and  more 1982± 1982± 1990± 1982± 1982± 1990± than tripled. 91 89 91 91 89 91 In the latter half of the ’s, overseas in- Real long-term interest vestors presumably believed that the dollar was rate 1 ...... 5.9 6.3 4.3 4.8 4.8 5.0 Earnings/price ratio 2 ...... 7.3 7.8 5.4 7.4 7.6 6.7 undervalued and that future returns to dollar- 3 Average total return ...... 6.8 7.3 5.0 6.5 6.6 6.1 denominated direct investments would be well 1. Data for individual countries were obtained from International Monetary Fund publications; these data have been weighted by their share of the FDIUS intercompany debt payable above their current values. U.S. ﬁrms’ assets position for the top 10 countries. 2. Data for foreign countries were obtained from Morgan Stanley Capital looked undervalued to those who believed that International,Perspective (various issues), and for the United States from Standard and Poor's Corporation,The Analysts Handbook (various issues); the foreign country data have been the dollar was below its long-run equilibrium weighted by their share of the FDIUS equity position for the top 10 countries. 3. For the United States and the top 10 investor countries, average total returns are a and purchasing-power-parity value. Although it weighted average of the real long-term interest rate and the earnings/price ratio, with the real long-term interest rate receiving a 35-percent weight and the earnings/price ratio receiving a is diﬃcult to determine the long-run equilibrium 65-percent weight. These weights represent the typical financial structure of countries that value their debt/equity ratios at market value. value for the dollar, a number of indicators sup- FDIUS Foreign direct investment in the United States  August      •

ported the view of investors who believed the curred when the dollar was below its  value, dollar was undervalued. For example, observed which may be regarded as a rough indicator of differences in real asset prices—such as those be- the dollar’s equilibrium value. tween Japanese and U.S. real estate and stock market investments—as well as estimates of the Rates of return on new direct investments.—The purchasing power of the dollar and of relative combined effects of higher relative rates of re- U.S. unit labor costs, suggested the dollar was un- turn on investments in the United States and dervalued. As chart  shows, the surges in  the depreciation of the dollar made U.S. returns in both the late ’s and the late ’s oc- look particularly attractive to overseas companies that had increased profits from sales to U.S. . According to Organisation for Economic Co-operation and Devel- markets and had thereby accumulated substan- opment estimates of purchasing-power parity, the dollar was undervalued by roughly  percent against the currencies of the major industrialized tial cash reserves. For these firms, increasing economies in . Estimates by the Federal Reserve Board indicated that U.S. unit labor costs were roughly  percent below those of the other major on , see Graham and Krugman, Foreign Direct Investment, – and industrialized countries. For a different perspective on the effect of the dollar –.

Table 4.ÐRate of Return on Assets of U.S. Companies in Year Prior to Foreign Acquisition Compared With All U.S. Nonfinancial Corporations [Percent]

1982 1983 1984 1985 1986 1987 1988 1989 1990

Foreign direct investment in the United States: Total ...... 1.6 0.9 0.7 1.8 0.8 2.4 0.3 0.3 0 Manufacturing ...... 1.6 −1.6 .8 2.8 .4 1.7 .8 3.0 .4 All U.S. nonfinancial corporations 1 ...... 3.6 4.6 5.2 4.8 4.0 4.9 5.5 4.6 3.8

1. Income is measured as total receipts less total deductions after total net tax liability, as for the U.S. Economy, 1960±91; the published totals have been adjusted to exclude claims on published by the Internal Revenue Service. Total receipts less total deductions, after taxes, have foreign affiliates. In this measure of total assets, tangible assets are valued at historical cost, and been adjusted to remove foreign source income and to add the part of the capital consumption claims on other nonfinancial corporations are excluded. adjustment in the national income and product accounts that adjusts for consistent accounting NOTE.ÐRate of return is measured as net income to total assets. at historical cost. Total assets is that published by the Federal Reserve Board in Balance Sheets     August   • their U.S. presence through direct investment was  from . billion in  to . billion attractive from an investment as well as an op- in . erations perspective. The combination of these With the slowdown in new , the rates of factors may even have encouraged companies return on existing  should rise as these in- abroad to buy financially distressed U.S. com- vestments mature. Rates of return on  have panies as long-term investments. Presumably, shown this pattern, and there is some evidence foreign companies either believed that they could that rates of return on  have tended to rise turn their U.S. investments around over time over time as well. However, long-term factors by using their expertise in product development, may continue to hold down  rates of return. process technology, and management, or they believed that they could achieve higher returns from Long-term factors an appreciation of the dollar. Vertical integration.—One fundamental reason During the ’s, about three-fourths of all for foreign companies to make direct investments  was for acquiring existing companies, and in other countries is to achieve vertical integra- about one-fourth was for establishing new com- tion. Owning both “upstream” raw material panies. For the companies established, rates of and production facilities and “downstream” dis- return were low or negative because of the startup tribution outlets may make it easier to further costs that all new firms experience. For the com- penetrate foreign markets. Through U.S. affili- panies acquired, rates of return were already low ates, foreign parent companies can better design, or negative: Between  and , the rate manufacture, distribute, and service products of return on assets for U.S. companies in the for the special requirements of the U.S. market. year before their acquisition by foreigners was Either through resale of the foreign parent’s prod- . percent, compared with . percent for all ucts by their U.S. affiliates or through sales of the U.S. nonfinancial companies (table , chart ). parent’s products as inputs to the affiliates, in- In addition, the foreign owners’ newly acquired creased sales of the parent’s products can achieve companies not only began with below-average re- economies of scale in home-country production, turns, but presumably these returns were lowered resulting in lower unit production costs for their further as owners restructured these companies products. by investing in new plant and equipment and in Besides company affiliation, U.S. affiliates of modernization of older plants, by writing-off and foreign multinational companies cite other rea- closing obsolete units, by increasing marketing sons for relying on imports from the parent efforts, and by aggressively pricing their products company, including product quality, assured to regain market share. sources of supply, and specialized product needs. Presumably, vertical integration and maximizing Recent developments.—By , many of the tran- total company profits also play a role. Whatever sitional factors that had encouraged direct invest- the reasons, foreign-owned affiliates do have a ment in the United States were no longer present. higher propensity to import than do U.S. multi- Other countries’ current-account surpluses with national companies in the United States. Imports the United States were reduced. Multinational by U.S. affiliates of foreign multinationals ac- companies needed to reduce debt and rebuild counted for  percent of their total purchases their balance sheets, and their bankers needed to of inputs in , compared with  percent for limit credit and meet higher capital standards. U.S. multinational companies (table ). Part of At the same time, the relative real rates of re- the higher propensity to import is explained by turn on investments were reversed, as U.S. real the practice of using U.S. affiliates mainly as dis- interest rates and returns to equities decreased in tribution outlets. Overall, U.S. affiliates’ imports relation to those abroad (table ). In late  for resale as a share of their total sales was  and early , the slide in the value of the dollar stopped, and its value began to increase, which . For a discussion of the increase in returns with age on  in manufacturing affiliates, see L.A. Lupo, Arnold Gilbert, and Michael Liliestedt, raised the cost to foreign investors of new direct “The Relationship Between Age and Rate of Return of Foreign Manufactur- investments in the United States. These devel- ing Affiliates of U.S. Manufacturing Parent Companies,” S  (August ): –. For a general discussion of the effect of age on profitability, opments combined to produce a sharp drop in see F.M. Scherer, Industrial Market Structure and Economic Performance, rd edition (Boston: Houghton Mifflin Company, ): –. . For a general discussion of vertical integration as a motivation for . For the most recently published data on U.S. companies in the year foreign direct investment, see Richard E. Caves, “The Multinational Enterprise before their acquisition by foreign parents, see “U.S. Business Enterprises as an Economic Organization,” in Multinational Enterprise and Economic Acquired or Established by Foreign Direct Investors in ,” S  (May Analysis (Cambridge: Cambridge University Press, ): – and ; and ): –. Scherer, Industrial Market Structure, – and –.  August      •

percent in ; for several direct investors, the domestic income of the foreign parent is lower share was much higher (table ). than that on the income earned by the U.S. af- With a vertically integrated company, the prof- filiate, the company can raise its total return by its resulting from economies of scale can be shifting income from the affiliate to the parent. allocated among the parent and its affiliates in or- This is achieved through use of transfer prices for der to maximize total returns. Such decisions can transactions between the affiliate and its parent, affect rates of return on individual investments. whereby the company raises the price of exports For example, a company that requires access to to the affiliate and lowers the price of imports a scarce raw material may accept a lower rate of from the affiliate. return on its “upstream” investments in mining In table ,effective tax rates on income from because such access will raise its global profits. investments in U.S. affiliates are compared with Alternatively, a company may accept lower re- those on income from domestic investments for turns on its “downstream” operations because, the top  foreign investor countries (as before, through vertical integration, it can raise total excluding the Netherlands Antilles). Computa- sales and take advantage of economies of scale tions of effective tax rates are subject to con- and technological efficiencies that raise its total siderable uncertainty and are sensitive to the profits. assumptions made regarding such variables as inflation and the financing mix. However, the rates Taxes.—Differences in tax treatment across coun- in table , which are derived from a recent study tries can significantly affect both the location of on effective tax rates by the Organisation of Eco- direct investment and, through “transfer pric- nomic Co-operation and Development (), ing,” the distribution of profits between parent  show that foreign parents in all but one of the and affiliate. If the effective tax rate on the  major investor countries may have an incen-

. For further discussion of the use of transfer pricing between parent tive to transfer income from their U.S. affiliates  and affiliate to reallocate income for tax purposes, see Graham and Krugman, to themselves. Foreign Direct Investment, –; and Mohammad F. Al-Eryani, Pervaiz Alam, and Syed H. Akhter, “Transfer Pricing Determinants of U.S. Multinationals,” Journal of International Business Studies, rd quarter, : –. Avoidance of tariffs and nontariff barriers.— For more information on how effective tax rates affect the flow of in- Tariffs and nontariff barriers raise the cost vestment to domestic or foreign locations, see Joel Slemrod, “Tax Effects on Foreign Direct Investment in the United States: Evidence from a Cross- of exports and provide an incentive for for- Country Comparison,” in Taxation in the Global Economy, Assaf Razin and Joel Slemrod, eds., (Chicago: The University of Chicago Press, ): –; and Kan H. Young, “The Effects of Taxes and Rates of Return on Foreign Table 5.ÐOperating Characteristics of Foreign Direct Direct Investment in the United States,” National Tax Journal (March ): –. Investment in the United States . See , Taxing Profits in a Global Economy: Domestic and International Issues (Paris: , ). Operating characteristic 1977 1987

Vertical integration (ratio of gross product to sales): Parents of U.S. multinationals ...... 37 37 Table 7.ÐEffective Tax Rates on Income from Investments U.S. affiliates of foreign multinationals ...... 18 21 in U.S. Affiliates Compared With Domestic Investments, Propensity to import for inputs (ratio of imports to total purchases of January 1991 inputs): Parents of U.S. multinationals ...... 9 8 U.S. affiliates of foreign multinationals ...... 27 24 Effective tax rate for in- Ratio of effective come from: tax rate for in- Local content (ratio of local inputs to sales): vestment in U.S. Parents of U.S. multinationals ...... 95 95 Investment affiliate to effec- U.S. affiliates of foreign multinationals ...... 79 81 in U.S. af- Domestic tive tax rate for filiate investment domestic invest- Source: U.S. Department of Commerce, Bureau of Economic Analysis; Council of Economic ment Advisers. Australia ...... 44 43 1.03 Table 6.ÐU.S. Affiliate Imports for Resale as a Share Belgium ...... 43 24 1.78 of Total Sales, 1987 Canada ...... 53 49 1.08 France ...... 46 38 1.22 [Percent] Germany ...... 46 23 2.00 Japan ...... 56 49 1.14 Luxembourg ...... 40 40 .98 All countries ...... 14.7 Netherlands ...... 40 30 1.34 Sweden ...... 48 30 1.62 Top 10 countries: Switzerland ...... 38 25 1.51 Japan ...... 33.9 United Kingdom ...... 38 37 1.04 Sweden ...... 21.6 Germany ...... 18.9 United States ...... 44 44 1.00 Switzerland ...... 11.1 Belgium/Luxembourg ...... 8.7 NOTE.ÐThe effective tax rate is calculated as the difference between the return before Canada ...... 5.3 corporate taxes that is required to generate a 5-percent return before personal taxes, and the return after both corporate and personal taxes divided by the return before corporate taxes. France ...... 4.7 The results are based on the following assumptions: Investment financing includes one-third United Kingdom ...... 3.6 each from intercompany debt, new equity, and reinvested earnings; the source of funds for Netherlands ...... 3.1 financing is from the parent's home country; inflation is at a 4.5-percent annual rate; and the Australia ...... 2.3 top tax rate is used for personal income. Source: Organisation for Economic Co-operation and Development,Taxing Profits in a Global NOTE.ÐImports and sales are identified by country of foreign parent. Economy: Domestic and International Issues. Paris, 1991, tables 5.4, 5.8, and 5.11.     August   • eigners to invest abroad. In recent years, and the second largest position at the end of the direct investments in the U.S. auto industry ’s. were presumably related to actual and poten- In terms of Japan’s rates of return and the tial restrictions on vehicle exports to the United factors that have driven these returns, Japanese States. In addition, direct investment in several  was typical of  as a whole during industries—televisions, typewriters, semiconduc- the last decade. Large current-account surpluses tors, and automobiles—may have been related in the ’s in combination with relatively low to antidumping suits and antidumping duties rates of return in Japan led to large flowsofdi- against foreign producers of these products. In rect investment capital from Japanese companies these cases, the motive for direct investment may that were seeking higher returns in the United be to avoid tariffs and nontariff barriers in or- States. Low rates of return for U.S. companies der to maximize total company returns, rather in the year prior to their acquisition, along with than to maximize returns on the direct invest- high restructuring costs after acquisition, led to ment. For example, a foreign manufacturer can low earnings by affiliates of Japanese parents. avoid antidumping duties by exporting parts and Vertical integration, indicated by U.S. affiliates’ components, on which there is no duty, for final heavy reliance on imports for immediate resale, assembly by the U.S. affiliate, rather than export- and practices related to vertical integration, such ing the finished product, on which antidumping as transfer pricing, further depressed returns on duties would be levied. direct investment. Effective tax rates on the domestic income of Japanese parents were lower Importance of country-specific factors than those on the income of their U.S. affiliates, which created an incentive to shift profits from The complex interrelationship among the factors the United States to Japan. Finally, tariffs and that have caused rates of return to be lower for nontariff barriers, such as Voluntary Restraint  than for all U.S. businesses is perhaps best Agreements (’s) and antidumping suits and demonstrated by an examination of the direct in- duties, may have induced Japanese companies to vestment activities of companies from different substitute assembly and production plants in the countries. This section contrasts the activities of United States for final goods exports from Japan. the two largest investor countries—Japan and the By contrast, for British , rates of return United Kingdom (table ). Together, these two and the factors that have driven these returns are countries accounted for nearly one-half of the largely dissimilar to those for all . Through-  position on a historical-cost basis in . out the ’s, the United Kingdom maintained In , the United Kingdom had the largest po- only small current-account surpluses and had sition, and it maintained that standing during the higher-than-average expected rates of return at ’s; Japan had the fifth largest position in  home. Although the flow of direct investment from the United Kingdom during this period . For a discussion of how foreign direct investment is motivated by the desire to avoid tariffs and nontariff barriers, see “Strengthening  An- was the largest in absolute terms, from  to tidumping Rules,” Economic Report of the President (Washington, : U.S. Government Printing Office, ): ; and U.S. Congress, U.S. Trade Re-  new flows accounted for a much smaller straints: Effects on Foreign Investment, report prepared by James K. Jackson percentage of the direct investment position of (Washington, : Library of Congress, ). the United Kingdom than that for Japan. Thus, while British investors probably also bought some Table 8.ÐFinancial and Tax Factors Affecting Japanese low-return U.S. companies and encountered sim- and British Direct Investment in the United States ilarly high restructuring costs, these low returns [Percent] would have been more than offset by higher re- All U.S. turns on the United Kingdom’s larger stock of Top 10 Japan United busi- countries Kingdom nesses more mature investments. A primary example of a mature investment is the British investment Real long-term interest rate: 1 Average for 1982±91 ...... 4.8 4.6 4.5 5.9 in petroleum, which has a diversified structure Average for 1986±91 ...... 4.6 4.1 4.0 4.8 within the United States that includes both up- Earnings/price ratio: 2 stream and downstream activities. Investment Average for 1982±91 ...... 7.4 3.0 8.7 7.3 Average for 1986±91 ...... 6.9 2.3 8.3 6.5 in this industry has boosted the overall British Effective tax rates, January 1991: 3 Investment in U.S. affiliates ...... 45 56 38 44 Domestic investments ...... 38 49 37 44 . Heavy reliance on imports for immediate resale by U.S. affiliates of Japanese parents and, more generally, all U.S. affiliates’ substantial de- 1. See footnote 1 to table 3. pendence on imports for use in production, probably also contributed to 2. See footnote 2 to table 3. reductions in rates of return from – because of the steep depreciation 3. Source is same as that for table 7. Effective tax rates for individual countries have been weighted by their share of the FDIUS total position for the top 10 countries. of the dollar.  August      •

rate of return; in contrast, Japanese investment ing little incentive for profit shifting. Finally, in wholesale trade—typically a more downstream imports from the United Kingdom have not gen- activity—has held down the overall Japanese rate erally been in industries subjected to ’s or of return. In addition, effective tax rates in the other nontariff barriers, thus creating no incen- United Kingdom are comparable with those on tive for earning less than the profit-maximizing British investments in the United States, produc- return on direct investment.